Financial Due Diligence: Surviving the Hardest Part of Selling Your Business
- Peter Flippen
- Jul 6
- 4 min read
In a previous post, we talked about due diligence in broad strokes, including the categories and the people you need in your corner. If you haven't read it yet, start there. It'll give you the lay of the land before we start getting into the weeds.
Due diligence is a bear under the best of circumstances, but just like any other project that’s too unwieldy to handle all at once, you need to break it down into smaller tasks. Let’s tackle one part that usually knocks sellers sideways more than any other: financial due diligence.
This is the one that will eat up the most hours and create the most headaches. It's also the one that has the biggest impact on your purchase price.
What Is Financial Due Diligence?
When the buyer engages an accounting firm to conduct a Quality of Earnings (QofE) analysis, what they're really doing is hiring a team of CPAs to rebuild your last three years of financials from scratch.
This goes well beyond a review of your books. The team is reconstructing them to verify that your earnings are exactly what you say they are. Anything that doesn't add up or even just raises an eyebrow is going to raise questions.
Get Ready for the Report Marathon
Before the QofE firm can ask you questions, they need data, a lot of it.
Expect to run hundreds of accounting reports. Think revenue by customer, monthly P&Ls going back three years, payroll summaries, fixed asset schedules, accounts receivable aging, accounts payable aging, job costing reports, and overhead allocations. The list goes on longer than you'd expect, and then it keeps going.
One of your options to limit the time you must invest is to give the QofE firm read-only access to your accounting system so they can run their own reports. They're going to want to pull data in formats you've never used and slice it in ways your bookkeeper has never tried. If they can do that themselves, you're not stuck fielding every pull request yourself. This won't eliminate the back-and-forth, but it will reduce it.
The Call That Leads to More Calls
Once you've handed over the first reports, the QofE team will schedule a call. Sometimes it's two calls. Either way, come prepared to talk through everything from your customer relationships to your revenue trends, any unusual one-time items, seasonal changes, and personnel-related issues.
You'll come off that call feeling like you've finally turned a corner. You're basically done, right? Then you get an email with another 50 questions the team needs to answer.
This is just how the process works. Your answers gave them a clearer picture, and a clearer picture always raises more questions that need to be answered. You'll work through that round, and another one will come. Then another. Every time you think you've answered the last question, there will be one more.
Why Are There So Many Questions?
All of those reports, calls, and follow-up questions are creating one deliverable: an enormous spreadsheet with more columns and tabs than you thought possible.
That spreadsheet is measuring your business against every accounting benchmark imaginable, from gross margin trends to EBITDA adjustments, revenue concentration, customer churn, working capital averages, one-time versus recurring expenses, and owner-specific costs that won't transfer with the business.
The goal is to determine the quality of your business’s earnings, including how predictable and defensible they are.
Does the QofE Confirm Your Numbers?
Your LOI should explicitly state how your purchase price was determined (usually a multiple of adjusted EBITDA, with that EBITDA figure defined).
If the QofE confirms that your adjusted EBITDA is what both parties expected, you're in good shape, and you can move forward.
If the QofE firm's analysis produces a lower adjusted EBITDA than what was represented, get ready for a conversation about your purchase price. This is called a price adjustment, and it's one of the more uncomfortable moments in any deal. How that conversation goes depends on the discrepancy’s size, how well you can explain it, and how thoroughly you can refute the buyer's analysis. Your advisor can step in here to help you formulate credible arguments for keeping the purchase price in the LOI.
The best way to protect yourself is to know your numbers before the process starts. Work with your CPA and advisor ahead of time to understand your own adjusted EBITDA and make sure it's defensible. For larger businesses, this means hiring an accounting firm to complete your own QofE analysis prior to starting a sale process.
One More Reason to Get a Copy of the QofE
Whether or not the QofE flags a price adjustment conversation, ask for a copy of the report when it's done.
Sellers sometimes don't think to do this, or assume the report belongs to the buyer since they paid for it. Technically, yes, the buyer commissioned it, but you can still ask, and most of the time you'll get it.
The QofE report contains a detailed working capital analysis, and that analysis is going to come back up when you get to the working capital peg negotiation later in the deal. Working capital is one of the most frequently misunderstood (and most frequently contested) parts of closing a business sale. Having the QofE in hand means you're not going into that conversation blind.
Making Financial Due Diligence Easier
Financial due diligence is hard. There's no sugarcoating it. It's time-consuming, repetitive, and has very high stakes. However, it's manageable if you go in with the right support.
Understand that the questions won't stop when you think they should. Know that the QofE is comparing your business against the metrics that drove your purchase price. Give the accounting firm the access they need to work efficiently, and don't leave that final report on the table (you're going to need it).
Next, we'll break down another aspect of due diligence. In the meantime, if you have questions about what financial due diligence might look like for your business, reach out. We've been through this process many times, and we're happy to walk you through it.
Source:
